Restraining Russian Oil: New Sanctions are Poised to Further Erode Moscow’s Faltering War Finances [highlights from forthcoming reports]

Given a chance to take their toll, new oil sanctions should accelerate the Russian energy sector's steep decline, intensify Moscow’s cashflow squeeze, and strengthen the West’s negotiating hand.

La Jeunesse de Samson (Samson’s Youth), Leon Bonnat (1891)

A full report on the new Russian oil sanctions should be released soon.

New measures target demand for Russian exports and mark the most significant development in oil sanctions policy since 2022

New measures taken by the US, the UK and the EU mark the most significant development in oil sanctions policy towards Russia since 2022. They are poised to substantially cut Moscow’s oil revenues in 2026 while intensifying the worst crisis in Russia’s energy sector since the 1990s. Given time to take their toll, they should accelerate the deterioration of Moscow’s ability to fund its war on Ukraine, strengthen the West’s negotiating position, and weigh on the Kremlin’s war calculus—and even more so if certain follow-on measures are taken.

The new sanctions seek to reduce demand for Russian oil among major importers, like India and Turkey. Additionally, they have the potential to sharply reduce oil tanker capacity available to Russian exporters. The imposition of these measures represents a more assertive use of the West’s considerable leverage over Russia’s energy sector.

As seaborne storage becomes constrained, Russia could be compelled to shut in between 1.6 and 2.8 million barrels a day for lack of buyers and/or tanker capacity

As oil importers and shippers adjust to the new risk environment, and Russia’s seaborne storage capacity becomes constrained, Moscow will be compelled to gradually reduce export volumes—for lack of buyers or tankers—possibly both. That, in turn, will compel Russian oil producers to undertake a sizeable, unplanned, winter-time shut-in of production, which could impair the future productivity of affected wells.

Based on market analysis, this report estimates Russia’s export volumes could, in time, fall by between 1.6 and 2.8 million barrels a day, as Russia’s seaborne storage capacity approaches its limits—assuming a basic level of enforcement (see Figure 1). That represents between 16% and 28% of Russia’s current oil production. In financial terms, this translates into an estimated $30 to $55 bn reduction in annual export revenues. It could also lead to a decline in state budget income of as much as 10%—possibly more.

Figure 1

A large, compelled shut-in could also harm Russia’s economy, weaken its leverage with key trading partners and undermine its leadership in OPEC+.

Apart from damaging the state budget, a large, compelled shut-in would have a range of other negative repercussions for Moscow. With the energy sector and its adjacent industries accounting for an estimated 30% to 40% of GDP, a large shut-in would harm the broader economy. It could also impair upstream production capacity, cause alarm and disaffection in the Russian public, weaken Moscow’s leverage over major importers, like India and Turkey, and undermine Russia’s leadership in OPEC+.

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Three new measures will help erode non-EU/G7 demand for Russian oil.

Three specific measures are driving this shift in sanctions strategy. One has attracted much attention, while the other two have been relatively underappreciated.

1. Sanctioning of 80% of Russian oil production. First, there are the high-profile designations by the US, UK and EU of leading Russian oil producers, putting nearly 80% of Russian output under sanctions.

2. UK/EU sanctioning of a major non-UK/EU refiner for its dealings in Russian oil. Second, there is the recent designation by the EU and the UK of a Chinese refiner for importing Russian oil, “including dealing with UK-specified ships” as expressed by the UK government. This marks the first time the EU and the UK have designated a major non-Russian-owned, third-country refiner for dealing in Russian oil. With this move, the EU and UK are leveraging access to their valuable markets and services to deter major refiners from importing sanctioned Russian oil. This new development should complement OFAC’s secondary sanctions capabilities.

3. UK/EU imposition of an import ban on refineries processing Russian oil (“closing the refining loophole”). Third, in January 2026, the EU and UK are introducing a ban on imports of refined products from refineries processing Russian oil. As by far the world’s largest importer of refined products and a prime market for large refiners in India and Turkey, this new measure promises to dampen demand for Russian cargoes, whether sanctioned or unsanctioned.

A stark choice for larger refiners: cheap Russian oil vs valuable Western services and markets

Together, these new measures present large, non-EU/G7 refiners with a stark choice: either stop buying Russian oil or risk losing access to valuable Western services and markets that underpin the global oil trade.

Russia’s likely evasion measures: smuggling, fraudulent rebranding, and deep discounts

Russia will likely attempt to circumvent these new measures by using two well-established stratagems: smuggling and fraudulent rebranding. Smuggling is unlikely to create new, large-scale demand for sanctioned oil. Refiners already disinclined to buy sanctioned Iranian or Venezuela barrels are unlikely to start buying sanctioned Russian barrels now—especially on a scale large enough to satisfy Moscow’s much larger needs. The risks are high—Russian oil is just too easy to track.

Smuggling will likely be most useful to expand sales to risk-friendly, independent “teapot” refiners in Shandong Province, China, that already import sanctioned Iranian and Venezuelan oil. But Beijing imposes import quota restrictions on these refiners. So, to keep exports to China from falling, Russia will need likely need to displace some of entrenched Iranian and Venezuelan suppliers for quota-constrained demand (see Figure 2).

Figure 2

Fraudulent rebranding, however, offers more promise. Marketing agents can broaden demand by falsely claiming that sanctioned cargoes were produced by unsanctioned Russian companies. Shrinking overall demand for Russian oil could help constrain this. Expanding producer sanctions from 80% to 100% of Russian output would eliminate it completely.

A third evasion stratagem is deeply discounted pricing. If prices are low enough, some refiners will find the economics sufficiently compelling—even if it means foregoing product exports to Europe. Deep discounting may also be needed to (i) win market share among risk-friendly Chinese importers and (ii) compensate refiners elsewhere for taking heightened Russia risk, especially if it becomes apparent that fraudulent rebranding is widespread.

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The partial collapse of Russia’s shadow fleet has caused renewed dependency on mainstream tankers.

Apart from declining demand by importers, a collapse in available tanker capacity could also leave Russian oil stranded and compel a large shut-in. Moscow’s ill-conceived shadow fleet project has been hit hard by attrition and sanctions; roughly half its capacity is either operationally impaired or has dropped out of normal service altogether (see Figure 3).

Figure 3

Consequently, mainstream tankers now transport nearly half of Russia’s seaborne exports (see Figure 4).

Figure 4

If mainstream tankers exit the Russia trade—either because of excessive risk, or a maritime services ban—Russia could have to shut in as much as 2 mm b/d for lack of available tonnage.

Were mainstream shippers to exit the Russian trade en masse, the resulting shortage in available tonnage could compel Russia to shut in some 2+ mm b/d. Most of that volume would likely drop out of Baltic flows, since average voyage times are longer and use more shipping capacity per daily export barrel.

Two things could cause such an exit:

1. mainstream maritime service providers judge that risks under the new regime to be too high; or

2. the EU/G7 scrap the price cap and impose a full ban on Western services. Recent press reports indicate a full maritime ban may be under consideration.¹

Moscow is staving off a shut-in by storing oil at sea. The resulting supply overhang is depressing the Urals price.

For the moment, the Kremlin is staving off a dreaded winter shut in by, in effect, storing stranded oil at sea. The resulting supply overhang has deepened the Urals discount to benchmark Brent beyond $25.00 per barrel—painful for Moscow, but still preferable to a large volume cut.² At some point, it will become impractical to keep increasing Russia’s seaborne storage volumes, compelling Russia to cut output.

Follow-on measures the US, UK and EU might take to intensify the impact of the new sanctions

Moscow will be worried about several potential follow-on measures that would intensify the impact of sanctions

• impose a ban on all maritime services: this would deny Russia access to the mainstream fleet;

• widen the company sanctions to include all Russian oil producers—this would make fraudulent rebranding much harder, effectively deny Russia access to the mainstream fleet; and likely increase the size of a shut-in

• sanction the remaining vessels in the shadow fleet: this would reduce Russia’s ability to deliver oil to key markets, like India and Turkey.

Either way—whether through lower prices or lower volumes—the new sanctions are poised to further erode Russian oil’s war-funding capacity and substantially strengthen the West’s hand in negotiations.

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Moscow’s war-funding strategy: (a) maximize cash extraction from the energy sector and bank lending; (b) avoid taxing the public.

These new sanctions threaten to further undermine Moscow’s faltering war-funding strategy. Since 2022, the Kremlin has sought to cover the extraordinary costs of its war on Ukraine by maximizing cash extraction from two sectors:

1. oil and gas (by tapping accumulated windfall savings and hiking taxes on current cashflows); and

2. banking (by aggressively expanding corporate lending, including soft loans for arms manufacturing).

The strategy worked well through 2024, but by 2025 surplus capital reserves were depleted. Worse still, the sectors now face serious structural problems.

Through 2024, this strategy worked well. It generated abundant cash that funded an expanding war budget, kept budget deficits low, fueled economic growth and created an illusion of unyielding Russian economic resilience. And, importantly, it allowed the Kremlin to avoid a politically perilous general tax hike.

In 2025, however, Moscow’s funding strategy began to falter as surplus capital reserves in banking and energy became—in the words of Russia’s Central Bank head—“exhausted”. Bank credit capacity had been overextended, while oil and gas savings had been heavily depleted.

Worse still, each of these sectors now face serious structural problems that are eroding their capacity to generate additional cash.

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The oil and gas sector has slid into its worst crisis since the 1990s, which is progressively weakening its capacity to generate free cashflows.

The oil and gas sector is sliding into its worst crisis since the 1990s—the result of confiscatory taxation, strategic blunders, Western sanctions (especially on oil field technology), increasingly challenging geology and drone strikes. Upstream oil production is suffering from falling productivity, diminished access to critical high-end technologies, stranded capex, exorbitant capital costs, underinvestment, short-sighted highgrading, increasing well costs, rising watercuts, and declining new-well flow rates (see Figure 5 and Figure 6).

Figure 5

Figure 6

These problems, along with weaker oil prices, help explain the accelerating decline in energy sector contributions to the Kremlin’s wartime finances (see Figure 7 ).

Figure 7

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Banks are suffering from $200+ bn of mandated lending to arms manufacturers that is not subject to fundamental credit-risk management requirements.

In the banking sector, the Kremlin’s excessive reliance on off-budget, state-directed lending to fund the arms manufacturing sector appears to have created a large, unhealthy anomaly in the banking system. In 2022, the Central Bank eased lending restrictions, unleashing a massive surge in corporate lending. Nearly a third of that lending has been directed to Russia’s 5 core arms manufacturing sectors through what appears to be a state-mandated, unlimited line of soft credit for defense. Total debt of these sectors now exceeds $200 bn and makes up over 23% of all corporate lending in rubles by Russia’s banks (see Figure 8).

Figure 8

To facilitate lending to the notoriously uncreditworthy arms sector, the state has introduced a special defense-sector regulatory framework that suspends fundamental credit risk management requirements. Defense sector loans are not subject to standard initial credit approvals. Nor are banks required to periodically reassess default risk on outstanding loans and set aside reserves when default risk increases. Instead, banks are allowed to simply assume the loan is in good standing and set aside no provisions as a buffer against a potential default.

This special defense-sector lending framework has created a dark pool of poorly understood and poorly managed default risk that is not reflected in official data.

This extraordinary suspension of fundamental default-risk management principles has created a large pool of opaque, unmeasured and poorly managed default risk at the heart of the Russian banking system. But because these loans can be marked as “good,” the actual default risk exposure of Russian banks is significantly higher than public disclosures suggest.

This likely explains reporting by Bloomberg, sourced from Russian banking insiders and documents, that three leading banks have internally discussed the potential need for a Central Bank bailout because “their assessment of the quality of their loan books is far worse that what official data show.”³ It’s worth noting that the state has injected close to $10 bn in capital from its wealth fund into several leading banks in 2025.

It is also making the banks far more cautious, leading to a collapse in lending growth in 2025, which has further undermined the state’s war-funding strategy

The Central Bank has warned banks not to count on the state automatically assuming the bad debts of state-owned companies and urged them to be much more conservative in their overall risk management.

This has helped drive a collapse in credit expansion in 2025, further undermining the Kremlin’s war-funding strategy (see Figure 9 ). As the Central Bank urged, the state has slowed credit expansion to the arms sectors (see Russia’s Hidden War Debt). Meanwhile, lending growth to the 73 other sectors making up the “real” economy has fallen below inflation.

Figure 9

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Faltering finances have forced the Kremlin to cut funding for the war and hike general taxes. The cash crunch is likely to worsen in 2026 and weaken Moscow’s negotiating hand.

As its war-funding strategy began to falter in 2025, the Kremlin found that a period of abundant, low-risk cash had abruptly ended, followed by one of risk-laden cash scarcity. It has been forced to do two things it hoped to avoid: cut funding for the war and raise taxes on the public (see Figure 10).

Figure 10

As structural problems in banking and energy progressively worsen in 2026—spurred on by the new oil sanctions—Moscow’s cash crunch will likely intensify, weakening its leverage at the negotiating table.

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About the author

The author is a Russian energy analyst, historian and former investment banker. For over 20 years, he worked at Morgan Stanley and Bank of America Merrill Lynch, where he was a vice chairman. He has advised companies worldwide and led numerous transactions, including Russia’s largest ever corporate acquisition and financing. He received an undergraduate degree and a doctorate from Harvard and a masters from Oxford, where he was a Rhodes Scholar. He is affiliated with Harvard’s Davis Center and conducts ongoing analysis of Russian energy and finance. He is also writing a history of the Russian oil industry, from 1860 to the present, and its impact on civil society formation.

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Credits

Credit: frontispiece, Public domain. Source: https://commons.wikimedia.org

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Disclaimer: No Advice

The author of this substack does not provide tax, legal, investment or accounting advice. This report has been prepared for general informational purposes only, and is not intended to provide, and should not be relied on for tax, legal, investment or accounting advice. The author shall not be held liable for any damages arising from information contained in the report.

© Copyright 2025, by Craig Kennedy. All rights reserved.

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Endnotes

1. Reuters, December 6, 2025.

2. Bloomberg, December 9, 2025

3. Bloomberg, July 17, 2025